Chapter 5

Question 1

Calculate Return on Equity (ROE)

Answer 1

ROE= Net Profit Margin x Asset Turnover x Financial Leverage

Question 2

Calculate Net Profit Margin

Answer 2

Net Profit Margin = Profit / Revenue

Question 3

Calculate “Asset Turnover”

Answer 3

Asset Turnover = Revenue / Total Assets

Question 4

Calculate Financial Leverage

Answer 4

Financial Leverage = Total Assets / Common Equity

Question 5

How do you calculate the “Economic Value” of a company?

Answer 5

EV= Market Value of Stock + Book Value of outstanding debt - Amount invested in cash and short term securities

Question 6

Where are Risk Analysis Ratios used

Answer 6

To analyze how well a firm services it debt obligations and ability to assume more.

Question 7

Why is a price-to-sales ratio of a company a better indicator of relative value compared to a price-to-earnings or price-to-book ratio?

Answer 7

Revenue, unlike earnings or book value is available for even the most cyclical or troubled firms.

Question 8

What is and how do you calculate Intrinsic Value?

Answer 8

Intrinsic Value is a measure of what an asset is worth.
Intrinsic Value = (EPS) x (1+r[“expected earnings growth”]) x P/E Ratio

Comparing Intrinsic Value to Current Market Value help determine if a stock is under or over valued.

Question 9

Where would an investor find detailed information about the depreciation method used by a company?

Answer 9

In the “Notes to Financial Statements”. This explains the companies accounting policies and detailed information about individual items in the financial statements.

Question 10

What is an “Ascending Triangle”?

Answer 10

It’s a bullish pattern that has a horizontal resistance line and a positively sloped trend line acting as a support.

Question 11

What is a “Symmetrical Triangle”?

Answer 11

Usually Indicates a continuation in stock direction, but may occasionally indicate a reversal.

Question 12

What Price or Chart Patterns help confirm whether a trend reversal has taken place?

Answer 12

A “Reversal Formation”

Question 13

What is a “Contrarian Indicator”?

Answer 13

An indicator that suggests buying a stock when most investors are bearish
or
suggests selling a stock when most investors are bullish.

Question 14

What is the “Simple Moving Average”?

Answer 14

An average of closing prices over a set number of days.

Question 15

What is a “Down Treandline”?

Answer 15

It shows a series of defending HIGHS over a period.

Question 16

What is the reserve life index?

What does it not include?

Answer 16

It represents the number of years it would take to deplete a companies existing reserves at its current daily production rate.

It does not include potential future reserve growth, exploration or changes in production levels.

Question 17

How do you calculate Reserve Life Index?

Answer 17

RLI=. Current Reserves \ (Current daily production rate x 365 )

Question 18

How does fundamental analysis aid in security selection ?

Answer 18

It studies the variables that affect a companies profitability, its industry and economy.
It determines its intrinsic value above or below the current stock price.

Question 19

What is the broadest measure of an economy’s success?

Answer 19

The change in a economy’s GDP (Gross Domestic Product)

Question 20

Beyond GDP, what are other key economic metrics?

Answer 20

Housing Starts
Retail sales
Employment Data
Consumer prices

Question 21

What can the slope of the yield curve help determine?

Answer 21

It can be used to help predict a recession, especially if the slope is inverted.

Question 22

What influence can international economic events have on domestic security analysis?

Answer 22

Global patterns changing can help determine the direction the domestic economy is going.
Global economic developments affect the North American economy and therefore market direction.

Question 23

What does Industry Analysis do to help select stocks?

Answer 23

Industry analysis can be used to determine which industry should be underweight, overweight or market weight in a portfolio. It helps with sector rotation, adjusting the portfolio weights of different economic sectors or industry categories when anticipating trends.

Question 24

What’s the difference between International Financial Reporting Standards (IFRS) and Generally Accepted Accounting Principles (GAAP)?

Answer 24

IFRS is almost entirely principle based where U.S. GAAP is primarily rules based.
GAAP is more rigid, where IFRS guidelines are more general in nature.

Question 25

What are the 4 major parts of a companies financial statements?

Answer 25

1. Statement of Financial Position
2. Statement of Comprehensive Income
   3.Statement of changes in equity. (It’s a link between the financial and comprehensive statements.
3. Statement of Cash Flows.

Question 26

What does a qualitative study of a firm look at? What is it based on?

Answer 26

A qualitative study of a firms business will consider how it generates revenue and process.
I helps assess the quality of a company based on earnings.

Question 27

What’s the merit of the Absolute Valuation Model?

Answer 27

It makes a point in-time estimate of intrinsic value based on a set of forecast company fundamentals.

Question 28

What’s the merit of the Dividend Discount Model? Where is it used?

Answer 28

It assumes the stocks intrinsic value is equal to the present value of a stream of future dividends. It’s suitable for valuing mature companies that pay dividends and have their payout that’s consistent with their profitability.

Question 29

What’s the merit of the Discounted Cash Flow Model? What are the two particular applications?

Answer 29

Assumes a stock intrinsic value is equal to present value of stream of future cash flow. It’s similar to the dividend discount model.

It uses 2 primary applications. Free Cash Flow to Equity (FCFE) (looks at cash available for dividends). and Free Cash Flow to Firm (FCFF)

Question 30

Primary Advantage and Disadvantage of P/E valuation?

Answer 30

Most widely used multiple for relative valuation. It’s uninformative when earnings are small or negative.

Question 31

Primary Advantage and Disadvantage of P/B (price to book) ratio?

Answer 31

Provides method for finding undervalued companies. It’s only useful when examining capital-intensive firms or those with high tangible assets.

Question 32

Primary Advantage and Disadvantage of Price-to-Sales (P/S) ratio?

Answer 32

It places a monetary value on each dollar of company sales. Revenue is available for even the most troubled or cyclical firms.

Question 33

When calculating price to earnings, how many quarters do you look at for the Earnings Per Share?

Answer 33

4 quarters